Intermarket Correlation Dance
Monday was Martin Luther King Day in the US. The price of gold dropped six bucks last week. The price of silver fell 26 cents, a greater percentage.
The price of gold can sometimes correlate well with the price of stocks. For example, from April 2009-July 2011. The price of gold went from $892 to $1,626, while in the same time period the S&P went from 841 to 1,289. The percentages are different - gold's was 82% and the S&P's 53% - but they moved together. And now, they seem to be inversely correlated.
In the short term, the gold-SPX correlation has clearly turned negative (in fact, a negative correlation is generally thought of as "normal"). Over the short to medium term, the correlation is cyclical, but it is indeed negative over the long term. The forces driving the cyclical element of the short term moves are an agglomeration of contingent circumstances, time leads and lags and perceptions. The latter include the choices of market participants regarding which of the macroeconomic gold price drivers to particularly focus on. [PT]
We often argue that the obvious explanation for price moves is wrong. But in this case, we think that gold is trading as the non-confidence asset. But let's add some color to this.
No one vacillates back and forth on a daily basis, believing that the system will collapse alternatively with "everything is fine." That's not what these safe haven/risk on trades are about. For now, gold buyers are not buying Armageddon or even insurance against systemic collapse.
The vacillation comes from them trying to figure out if the Fed has effectively added a third mandate: a rising stock market. They're wrong, the Fed hasn't done any such thing. But so long as people believe in the mythical Greenspan put (or now, the Powell put), they will trade this way.
The Fed cares about credit, not stock prices. But in a near-zero interest rate world the price of stocks would be astronomical - but for concerns about credit. So the more the Fed can do to fix credit, the more stock prices can go up. And by fix, of course we mean enable profligate and zombie* borrowers to borrow more, at dirtier-cheaper rates. So long as the Fed is doing this, then speculators feel safe to buy more assets including stocks. And why shouldn't they?
Anyway, people are still very much in a bubble frame of mind. When facing the prospect that the Fed cannot or will not keep pumping air into the stock market (as they picture it), they just turn to the next asset to bet on. In this case, gold.
If the price of gold rises enough, then many may conclude that "it's on," and gold could get a risk-on greed bet too. When they finally lose the bubble mentality, then they may buy gold much more than today. But, then, it won't be for price gains. We will see that trend change long before the price action shows it.
So let's take a look at the only true picture of the supply and demand fundamentals of gold and silver. But, first, here is the chart of the prices of gold and silver.
Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). It rose this week.
Here is the gold graph showing gold basis, co-basis and the price of the dollar in terms of gold price.
We just rolled to the April contract. The rise in the co-basis, ongoing since mid-December, is evident. This is despite (or not) the drop in the value of the dollar (inverse to the rise in the price of gold). And also with Friday's $10 sell-off in gold.
The Monetary Metals Gold Fundamental Price fell $10 to $1,334.
Now let's look at silver.
As the price of silver fell more, the co-basis (scarcity) rose more. The Monetary Metals Silver Fundamental Price is unchanged $16.00. Isn't that incredible? The market price dropped almost two percent and our model of the fundamentals is stable.
*the Bank for International Settlements defines a zombie corporation as when profits < interest expense.
Charts by: Monetary Metals
Chart and image captions by PT
© 2019 Monetary Metals
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.